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Stable growth is good growth
at 50 South Capital
N
The fund of hedge funds team is seeing more interest in customised solutions
from institutional clients
By Chris
Clair
early four years ago, managing director
Robert Morgan said he thought his
hedge fund team at Northern Trust Alternatives Group would be disappointed if assets under management weren’t
at $5 billion in five or six years.
A lot has happened since then. Hedge
fund returns flattened out. The fund of
funds industry underwent a wave of
consolidation and retrenchment as
firms had a harder time justifying their fees to institutional investors that began opting for direct investments
or getting out of hedge funds entirely. And, in 2015,
Northern Trust Alternatives Group was carved out into
its own entity – 50 South Capital Management, named
for the address of Northern Trust’s iconic building on
LaSalle Street in Chicago.
In early 2013 Northern Trust Alternatives Group had
$2.3 billion in assets and the fund of funds industry was
enjoying its best performance since 2009, according to
the InvestHedge Composite Index. A doubling, or more,
of assets didn’t seem out of the realm of possibility.
As of 31 December, 50 South Capital had $3.1 billion
in hedge fund assets. It’s not lights-out, but given all
that’s gone on in the fund of hedge funds space over the
past few years, any growth is good. And Morgan and his
team say they’re happy about the stable growth the firm
has managed over the past couple of years.
Jessica Chu, vice president for product strategy and investor relations at 50 South Capital, says the firm had
more than $300 million in inflows in 2015 and another
$300 million total last year into its strategies. “It’s good
growth, especially in light of the broader space,” she
says.
Performance has helped drive growth. Going forward,
Morgan says markets today are set up nicely for hedge
fund managers, and that clients see that potential.
Tristan Thomas, director of portfolio strategy at 50
South Capital, says the rebranding in 2015 also helped
growth by making the group more visible. “We’ve had a
number of instances where we’ve had investors – potential investors – call us up, enquiring about what
we’re doing,” Thomas says. “Previously, when we
weren’t 50 South Capital, they didn’t really have an in-
terest in working with a group that was inside a larger
bank. A separate entity, with more autonomous decision-making has driven greater client interest.”
And that was one of the main goals behind the move
– combine the greater autonomy of a boutique firm
with the international resources of Northern Trust’s
16,000-plus employees and nearly $1 trillion in assets
under management. In announcing the formation of 50
South Capital, Northern Trust Asset Management president Stephen Potter said the spin-off would better align
the firm’s alternatives talent with the institutional and
other investors interested in that space.
“That’s the beauty,” Morgan says. “It’s like we’re a little boutique within this large structure that has vast
resources to draw on as needed. That’s been a nice
combo.”
Morgan says another benefit of the spin-out was the
effect it had on employees – the sense of ownership is
motivating. “It’s fun to grow a business and be a part
of that,” Morgan says. “And I think it helps us attract
talent.”
Indeed, since 2013 50 South Capital has seen some
senior-level people depart for other firms, only to be replaced with new talent. 50 South Capital does not comment on personnel moves, but Anthony Zanolla, who
was the head of hedge fund portfolio management for
eight years, left in 2014 to become a portfolio manager
at K2 Advisors. Likewise Tony Lizzuzzo, for nearly four
years Northern Trust Alternatives Group’s director of research, left in mid-2015. He’s now senior investment
director at Cambridge Associates.
Thomas took over Zanolla’s duties while John Frede
joined as 50 South Capital’s director of manager research in the fourth quarter of 2015. He previously
worked at Mesirow Advanced Strategies, where he was
head of hedge fund research management.
And in October 50 South Capital hired Citadel’s former director of global distribution, Chris Bires, for a
newly created role of managing investor relations and
business development.
Overall, 50 South Capital had $6.7 billion in assets as
of 31 December. That total includes both hedge funds
and private equity funds. 50 South Capital is also building out its capabilities in private credit, infrastructure
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Robert Morgan
and real asset investments.
Morgan says generally, 50 South Capital’s
client base is becoming more institutional and
more interested in customised solutions. The
firm has seen strong client growth in the foundation and endowment space, and in corporate pension plans, Morgan says. Of the $3.1
billion in hedge fund assets, just less than half
is in commingled funds of funds and $1.3 billion is under advisement in customised solutions.
That’s a decent amount when you consider
that 50 South Capital’s specialty is investing in
smaller managers, or managers with less than
$1 billion in assets. Chu says the median size
of the hedge funds with which the firm invests
is about $600 million.
50 South Capital has traditionally sought to
identify talent early. Nearly three-quarters
(74%) of managers with which 50 South Capital has invested had less than $1 billion in assets under management at the time of investment. While on the long/short equity side
managers often have less than $1 billion,
there are certain strategies where size and
scale can be an advantage, such as distressed
credit. However, Frede says that conversations
with fixed-income divisions regarding liquidity and crowding rules changed the 50 South
Capital team’s perspective to focus on smaller,
more nimble credit managers that can “trade
under the radar and not get hung up”.
Those conversations took place partly because Thomas sits on a broader committee at
Northern Trust that includes the leaders of
various investment teams. Once a month
these team leaders meet for discussions focused on the markets. Thomas describes it as
an “unfiltered discussion”.
“There’s no sales spin. These are just completely unbiased opinions that really form the base of
our own macro view which we then adjust to
February 2017
Tristan Thomas
John Frede
incorporate the team’s view on hedge fund
strategies. This serves as a framework for positioning,” Thomas adds. “It’s a huge benefit.”
For instance, Frede says in late 2015 50 South
Capital saw that the opportunity set in the distressed credit of energy firms, retailers, and
industrial companies looked to be improving.
Frede says sometimes in the distressed space
investors look to larger managers because they
have teams of lawyers who can comb through
the complex bankruptcy documents looking
for investment opportunities. But the fixedincome division observed that moving smaller
blocks of bonds – say $25 million – was not
difficult. However, moving larger blocks was
proving more difficult because a lack of liquidity was driving up bid-ask spreads.
“So that made us think a little bit differently
about how we should be approaching credit in
that we didn’t want to enter into crowded
trade risk,” Frede says. “That was a little bit
counterintuitive, but that view was very much
formed by connecting with our fixed-income
group. Having a resource that is unbiased is
helpful in charting the course for how we allocate.”
Frede says being a subsidiary of a larger institution with experts on whose wisdom and ex-
“
We look at what the
manager does and the
universe of securities they
trade and we form a
hypothesis on why we think
the manager is skilled and
whether we think that can
be repeated over time
”
perience Frede and the rest of the team can
draw, combined with the nimbleness to
change course quickly in response to that information, makes all the difference.
And the benefits go both ways. Thomas says
at the same meeting where the investment
team leaders talk strategy, he shares what
hedge funds are doing, how they’re positioning themselves and what they’re thinking.
Performance has always been about having
an edge, and in the fund of funds space that
edge seems increasingly thin. Some funds of
funds hang their hats on their boutique culture and independence, others boast about
their scale. 50 South Capital can claim a bit of
both. The insights available to it from the rest
of Northern Trust and the ability to react
quickly have both contributed to Northern
Trust’s performance and, indirectly, its growth.
Two-thirds of the value generated by 50
South Capital can be attributed to manager selection. The other third comes from allocation
decisions.
50 South Capital tends to run smaller, more
concentrated portfolios. The firm has about 50
managers with which it actively invests. Depending on the mandate, manager concentration could range from as few as a handful to as
many as 40.
Frede says 50 South Capital looks top-down
at where it should be investing and then analyses what its capacity is with managers specialising in those strategies. The results of that
analysis drives 50 South Capital’s priorities
when it comes to finding managers in long/
short equity, event-driven and credit, relative
value and macro.
“I would say typically there are two to three
high-priority managers in each strategy that the
team is working on, and then there’s the manager opportunities behind that that we’re watching closely,” Thomas says. “That list is pretty dy-
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namic. We like to kill things early in the process
when we know it’s not going to move forward
and we move on to the next opportunity.”
The competition among managers for 50
South’s capital can be intense. The firm’s research team meets with 500 to 600 managers a
year, but thousands reach out trying to get a
meeting. Sometimes those managers can get
pretty creative with their efforts. They come in
from meetings elsewhere in the bank and call
anyone and everyone on the team. Firm
spokesman John O’Connell says some managers have even called him. Collectively 50
South Capital’s executives and researchers
have almost 200 years of experience. Thomas
says their business cards are scattered throughout the industry.
Cold calling isn’t always effective. Frede says
primarily 50 South Capital uses word of
mouth from its existing managers to source
new talent. “They know who they’re trading
against, who’s smart, who’s not,” Frede says.
50 South Capital also uses word of mouth
from inside Northern Trust – which includes
custody and administration services – and
from capital introduction events.
Managers want to get on 50 South Capital’s radar because Frede says the firm has net positive
flows, which means it has capital to put to work,
and because its client base is an attractive mix of
high-net-worth and institutional investors.
The biggest challenge for the research team
isn’t finding managers, it’s sifting through all
of them.
Frede says 50 South Capital looks for skill
first because skill is repeatable. He defines
“skill” as alpha, the ability to generate “true,
different, unique returns that aren’t correlated to the market.”
50 South Capital’s research process is what Frede describes as evidence and expectations-based.
“We look at what the manager does and the
universe of securities they trade and we form
a hypothesis on why we think the manager is
skilled and whether we think that can be repeated over time,” Frede says. “So that’s where
we marry this top-down allocation view with
the current market today, do we think that the
skill is going to be effective in that market environment? We’re looking for points of independent verification to support the view of
whether they’re actually skilled or not. And
that builds our confidence in our overall hypothesis and manager assessment.”
It takes about 100 hours for 50 South Capital
to vet a manager to its satisfaction – more in
some cases, less in others. Most of that time is
spent conducting a qualitative assessment,
Frede says, speaking to the portfolio manager
to understand the investment process and to
other members of the team to build the case
for why the manager fits with 50 South Capital’s hypothesis of what makes it special.
Frede and Thomas say 50 South Capital has
no set type of manager it looks for; the firm
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“
Frede says 50 South has
exited a few managers in
2016 because they saw
those mangers’ strategies
being opportunitychallenged in the next nine
to 18 months
”
doesn’t have a pre-conceived notion of a “50
South-style manager.” While each manager’s
attributes are unique, a few that tend to appear across the programme are smaller managers, managers that take singular risks, and
managers that run short books. “We don’t
tend to do a lot with longer-biased managers
or managers that are just using indices on the
short side,” Thomas says. “We want guys that
are doing real alpha-driven shorting throughout the portfolio.”
Frede says that leads to hedge fund portfolios
that demonstrate why an investor should be in
hedge funds in the first place – a return or
alpha stream that’s different from the traditional assets in the portfolio. Hedge fund investments should diversify the investor’s portfolio and provide some downside protection.
“At the moment we’ve got multiple managers that are actually running net short,” Thomas says. “There’s a real focus on shorting and
being opportunistic around positioning. We
really like managers in the long/short equity
space that might be, when the opportunity is
there, 30% net long and when the opportunity
set flips they might be 10% net short. But
they’re not dogmatic about their exposure;
they can move with the opportunity set.”
Sometimes, though, the opportunity set just
isn’t there, in the 50 South Capital team’s
view. When a strategy appears to be facing
longer-term headwinds, it can be time to move
on from a manager. Other reasons for redemption range from a key people leaving to an unexpected drawdown to an unexpected increase
in assets, which could take the manager beyond the size at which 50 South Capital feels
comfortable.
Any member of the investment team can,
with the support of one other team member,
initiate the redemption process from a manager. This can lead to an immediate redemption, or the manager may be placed on a watch
list to determine whether the issues at hand
can be remedied in a time frame the investment team considers reasonable.
Turnover among the list of approved managers at 50 South has averaged about 20% per
year. Which isn’t to say that the firm’s entire
roster of managers has turned over in the past
five years. One unnamed long/short equity
manager out of London has been with 50
South Capital since 2007.
Frede says 50 South has exited a few managers in 2016 because they saw those mangers’
strategies being opportunity-challenged in the
next nine to 18 months. For example, 50 South
Capital redeemed from one activist manager
who’s been managing money for the fund of
funds for the past five years, not because there
was anything wrong organisationally but because 50 South Capital’s team thinks the particular brand of activism practiced by that
manager is late in its opportunity cycle.
“If the market environment turns in their
favour, we hope they will open the dialogue
with us again,” Frede says. “We try to be as
clear as we can with managers as to our reasons for exiting so there isn’t any confusion or
hard feelings.”
50 South Capital uses RiskMetrics for ongoing monitoring through position-level transparency. The firm also speaks to many of its
managers at least monthly to conduct a performance check-up and understand what the
larger contributors to performance are at the
time. The frequency of these check-ins is determined by a risk-based monitoring philosophy that flags smaller or new managers, or
managers who run more complex strategies,
for more frequent evaluation.
“That feeds back to Tristan’s group on the
portfolio team,” Frede says. “One of the most
challenging things about his job is the managers are shifting their allocation. Tristan has to
be thinking about what that means to the
broader programme. That position-level risk
transparency is really helpful in looking at
that on a monthly snapshot basis to see where
the ground is. And then that informs our forward looking views as well.”
Beyond that 50 South Capital performs more
of a formal check-up on its managers every six
months to make sure the investment hypothesis is still valid.
Looking ahead, 50 South Capital may yet see
$5 billion or $6 billion in assets, but the team
seems to be in no hurry to get there. Beyond a
planned acquisition in 2016 of Aurora Investment Management that fell through, 50 South
Capital has no plans to grow by acquisition.
And the Aurora deal wasn’t about growth as
much as it was about combining with a complementary firm.
Future growth at 50 South Capital is likely to
be in customised funds, Frede says, because
the reasons clients get into hedge funds are so
diverse. Some want returns while others want
diversification and still others are seeking defensive positions. Customised funds can accommodate those differences.
“The institutional community is thinking of
how hedge funds can impact a client’s overall
asset allocation, rather than just be a standalone slice of their asset allocation pie,” Frede
says. “Hedge funds are no longer viewed as a
stand-alone entity, but rather a solution for
the whole portfolio.”
February 2017